Think Twice Before Taking a 401(k) Loan: Congress

By Glenn Ruffenach

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If you’re thinking about borrowing money from your retirement savings, Congress wants you to think twice.

Legislation introduced last week in the Senate seeks to curb loans from 401(k)s and related retirement plans. The proposal coincides with a new study from Aon Hewitt, a management consulting firm and unit of Chicago-based Aon Corp., which shows that – in the wake of the recession – a record number of people are dipping into their nest eggs before retirement.

At the end of 2010, more than one-quarter (27.6%) of participants in defined-contribution plans had a loan outstanding, according to Aon Hewitt. The average loan balance was $7,860, which accounted for 21% of the participants’ total plan assets. Perhaps most worrisome, almost three out of 10 participants (29.2%) had two loans outstanding, and 2.5% had more than two loans. (The majority of plans, 58%, allow employees to have two or more loans outstanding.)

Yes, you might know that borrowing from retirement savings isn’t the best of ideas – but few people realize that they’re penalizing themselves three times in doing so.

First, you’re costing yourself a potentially significant amount of interest. (After all, when you borrow money from a 401(k), your nest egg is smaller and earns less money.) Second, when you pay back the loan, you’re using after-tax dollars; by contrast, contributions to a 401(k) are made with pre-tax funds. Third, such loans aren’t tax-deductible. (That compares with a home-equity loan, for instance, which allows you to deduct the interest on your taxes.)

A worst-case scenario is a person with a loan outstanding who loses his or her job. Most retirement-savings plans, according to Aon Hewitt, require employees to repay loans in full – usually within 60 days – once they walk out the door. In such cases, almost 70% of workers default on repayment. The upshot: The unpaid funds are considered taxable income, which can add to an unemployed individual’s financial burdens.

How does all this affect your retirement security? Aon Hewitt estimates that employees (in the early to middle part of their careers) who take a five-year loan – and, as a result, aren’t contributing to their nest eggs for that period of time – will see future retirement income fall 10% to 13%. With two loans, the drop-off nearly doubles. (Click here to figure out how much it will cost you to borrow from your 401(k) or 403(b)?)

The Senate bill, introduced by Wisconsin Democrat Herb Kohl and Wyoming Republican Mike Enzi, seeks to ease some of the pressures on borrowers, as well as make it somewhat tougher for workers to take out loans in the first place. Called the SEAL Act (Savings Enhancement by Alleviating Leakage in 401(k) Savings), the legislation would:

– Extend rollover periods. Instead of an immediate repayment (or possibly defaulting), borrowers who lose their jobs could contribute the amount outstanding on their loan to an individual retirement account by the time they file their taxes for that year.

– Allow contributions to plans following hardship withdrawals. Normally, a worker who receives a hardship withdrawal from a 401(k) (for, say, medical expenses) can’t contribute to retirement savings for at least six months. The act would end that ban.

– Reduce the number of loans. Plan participants would be limited to no more than three loans at any one time. (Currently, employers set the number of loans available.)

Comments (5 of 42)

The top commander of U.S. forces inside the Middle East singled out Iran as the only country actively attempting to destabilize and spark violence inside the region.
“Iran presents essentially the most important regional threat to stability and security,” Gen.
James Mattis, head with the U.S. Central Command, mentioned at a Senate Armed Solutions Committee hearing Tuesday. “Its reckless behavior and bellicose rhetoric have produced a high possible for miscalculation.” Read also: U.S and others offer you to restart nuclear talks with Iran Listing Iranian weapon capabilities like ballistic missiles, long-range rockets, mines, tiny boats, cruise missiles and submarines, Mattis stated future threats in the region “are increasingly maritime” and known as on Congress to protect the budget to let for correct equipping of his forces.
“I anticipate that we are going to need a lot more maritime missile defense, anti-fast attack craft capabilities, amphibious ships and mine-countermeasure capability, and intelligence, surveillance, and reconnaissance assets,” Mattis said in written testimony.
Mattis also detailed how Iran was helping Syria, a connection CNN’s Barbara Starr reported about on Monday.
The general also warned of Syria’s weapons stash, saying the country’s regime features a substantial amount of chemical and biological weapons, a substantial integrated air defense program, and a large number of shoulder-launched anti-aircraft missiles.

12:14 pm March 7, 2012

bangdssml wrote:

We operate in China for some memories,
and close friends to China to play there?
The most memorable China has a lot of delicious food, see a good deal of lovely women in Sichuan, China, they are quite like spicy food! Their specialty is Spicy Girl. I met my life goddess of fate, we thought a watch output a feeling, a watch retailer! Like an armani watches she bought, and we chatted up! Regrettably, I have to work can not stay there to accompany her.
This is my regret!

5:30 pm July 19, 2011

the cleaner wrote:

congress can KISS MY A**!!!! How about they write a bill to quit borrowing EVERY YEAR and adding to the deficit. IDIOTS!!

8:26 pm June 23, 2011

Sam wrote:

Wow, $7860 loan = 21% of the 401(k)? You realize that 401(k) is worht about $37,500? Really? Why bother? Calculate the lost earnings, plus the interest and you are still talking about less then a cup of starbucks coffee. Why bother with the whole 401(k)? The whole thing is a sham anyway. It’s nothing more than a guaranteed income stream for the IRS. There will be lots of ‘you’re an idiot” comments, but you are better off in a universal life or whole life program; roi, liquidity and freedom over your money. First thing everyone should do is operate their entire financial life out of a line of credit. That’s right, a line of credit. Do what I did; truthinequity.com. These people are brilliant!!! Abandon EVERYTHING YOU’VE EVER BEEN TAUGHT ABOUT MONEY. Start over! Go talk to these people!

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Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.